With regard to the capital adequacy’s provisions, Saint Charles Bank is expected to disclose financial management data relating to its policies and financial risks. In this respect, Saint Charles Bank has begun publishing information on its financial risk management on its website. Some of the data is, actually, a reproduction of the data that has been presented in Saint Charles Bank’s Credit Risk Annual Report for the year 2010. The information that has been presented in this paper represents the Risk Report for the year 2010, unless otherwise stated. The information represents a holistic view as it has already been audited to the satisfaction of Saint Charles Bank’s internal and external auditors.
Risks and Objectives Policies
Saint Charles Bank’s entire risk model has been accomplished as per the policies and instructions that have been approved by the organization’s Board of Directors. The policies and instructions act as scope setters for the Saint Charles Bank’s activities and risk takings. The Board’s instructions are used to determine the liquidity and credit risks as well as the market risks. Additionally, the members of the Board have issued a policy defining the acceptable levels of market risks so as to facilitate the establishment of the guidelines that facilitates Saint Charles Bank’s exposure to the market. In addition, the credit policy establishes the guidelines that facilitate the management of credit limits and counterparties.
The members of the Board emphasize on applying the policies and instructions so as to facilitate the implementation of the risk management framework. The Management Board utilizes the policies and instructions while implementing the management framework. The ongoing tasks of controlling and monitoring risks are the responsibilities of the Risk Director and his team. The tasks are undertaken in the risks management department. During the trading period, the members of the Board do monitor the organization’s necessary risk parameters including foreign exchange and CFDs, as well as the related products. This facilitates the evaluation of the margin levels as well as the counterparty exposure boundaries; this happens in response to those continued variations in the trading volumes and marketing conditions (Musselman 1992, p. 45).
The variety of risks that Saint Charles Bank is exposed to can be expressed as indicated below:
Market risk: the risk which is associated with the decrease of a portfolio due to the market movements of the risk components.
Credit risk: the risk that is associated with the counterparties of the bank failing to oblige with their promises.
Operational risk: the risk which is associated with the loss resulted from failed or inadequate systems, people, and process.
Liquidity risk: the risk that results from the inability to meet obligations in time.
Business risk: the risk which is associated with macro-environments as well as the competitive situation in the banking sector.
Market risks are defined as those risks that are associated with the loss which results from movements in such market risk factors as equity prices, foreign exchange, interest rates, and commodity prices. Market risks do arise when clients are handled in a manner that influences the market maker functions or the inventory position of the organization.
The Saint Charles Bank’s prime objective with regard to the market risks is to ascertain that, for the purpose of appropriateness, risk taking is approved by the members of the board. This would, therefore, facilitate monitoring and reporting.
The members of the Board have approved the Saint Charles Bank's marketing risk policy. Moreover, the Directors have set the limits for all the main types of risk factors with the instructions from the Board. The limits are allocated with the Treasury and the trading organization in mind. The limits are then monitored by the department of risk management, and the report on the utilization of the guidelines is issued to the Board of Directors at the end of the trading period.
The Bank's market risk is monitored and quantified as per the Value-at-Risk, exposure, and the loss limits. Value-at-Risk represents the technique that is utilized for the purpose of assessing the probability of having a portfolio loss, and this assessment is founded on the statistical analysis of historical prices, volatility and development. Loss and exposure limits usage is monitored with time and on a continuous basis. On the contrary, the Value-at-Risk limit of utilization is assessed at the end of a day.
With regard to foreign exchange, exposure limits are partitioned into extra granular levels on the basis of such characteristics as volatility, liquidity, and market availability. With regard to the options associated with the foreign exchange, much of the limits are, actually, set by using such Greek symbols as gamma, delta, theta, and vega. Such limits ascertain that the various risk elements like the underlying price, time-decay, and volatility are properly managed. The exposure limits regarding equities are determined for gross, single, and net types so as to cater for the market wide concentration and movements’ risk. As was mentioned before, the limits of exposure on various commodities can be set as single, net, and gross. Single levels are further broken down in a manner that facilitates the avoidance of risks concentration on any one segment.
Saint Charles Bank utilizes a Value-at-Risk model for the purpose of estimating the market risk. Value-at-Risk approximates the potential loss of portfolios, especially where there are defined holding periods. The Bank evaluates the Value-at- Risk through Monte Carlo simulations for the purpose of accounting for the non-linear instruments. The limits across this trading organization are defined as per the Value-at Risk. Supplementing the Value-at-Risk requires the implementation of the framework tests. Based on important risk factors, stress tests are constructed for the purpose of determining the Saint Charles Bank's vulnerability. This helps in meeting some of the large and unexpected changes that risk factors present. Furthermore, stress tests replicating the changes that are experienced in some known historical cases are also undertaken. Daily as well as weekly loss boundaries also exist for the purpose of preventing losses that are larger than those that have been approved as per risk appetite.
The Bank utilizes acceptable third-party systems while calculating the Value-at-Risk, delta, theta, gamma, and vega. Principles that govern the calculation relating to an exposure are provided in the instructions that are issued by the Board.